The Supreme Court on Wednesday in a plea filed by Franklin challenging the constitutional validity of Regulation 39 to 42 of SEBI (Mutual Funds) Regulations, 1996 after accepting the poll results, decided to wind up the following Mutual Funds Scheme in view of Regulation 18 (15)(c) of Securities and Exchange Board of India (Mutual Funds ) Regulations, 1996 namely –
(i)Franklin India Low Duration Fund (Number of Segregated portfolios – 2)
(ii) Franklin India Ultra Short Bond Fund (Number of Segregated portfolios – 1)
(iii) Franklin India Short Term Income Plan (Number of Segregated portfolios – 3)
(iv) Franklin India Credit Risk Fund (Number of Segregated portfolios – 3)
(v) Franklin India Dynamic Accrual Fund (Number of Segregated portfolios – 3)
(vi) Franklin India Income Opportunities Fund (Number of Segregated portfolios – 2)
The bench of Justice Abdul Nazeer and Justice Sanjeev Khanna expressed disclination to touch upon the facts of the case, keeping in view the proceedings with respect to the issuance of show-cause notices are in abeyance. Also, observed that Franklin did not address the bench on the point that the Forensic Audit Report has not been made available to them. However, the two-judge bench referred to the news reports or articles by Franklin mentioning various irregularities in Preferential payments, breach of trust and mismanagement in the deployment of funds of the scheme, violation of investment objectives stated in the offer document or scheme information document, and breach of trust by withholding price-sensitive information, etc.
The Court held that “ we clarify that our observations in this Order and the earlier Order should not be read as binding factual findings or conclusions on any disputed facts, which could be a subject matter of a show-cause notice and consequent decision. Of course, the legal interpretation of Regulation 18(15)(c) and Regulations 39 to 42 to the extent indicated above are conclusive and binding. For clarity, we would also observe that any finding given by the High Court on facts or even on legal issues not subject matter of this Order or our earlier Order dated 12th February 2021 would not be treated as conclusive and binding as the findings are sub-judice and pending before this Court on interpretation as well as merits.”
The High Court Judgment which is being challenged holds the view that the decision of Trustees to wind up a scheme under clause (a) to Regulation 39(2) must obtain the consent of the majority of the unitholders in pursuant to Section 18(15)(c). The regulation reads herein as under –
(15) The trustees shall obtain the consent of the unitholders— (a) whenever required to do so by the Board in the interest of the unitholders, or (b) whenever required to do so on the requisition made by three-fourths of the unitholders of any scheme, or (c) when the majority of the trustees decide to wind up or prematurely redeem the units.
The Bench noted the SEBI arguments which contended that in regard to wounding up of Scheme, when the trustees form an opinion as per clause of Regulation 39(2), or even when as per clause (C) of such regulation, SEBI directs to wind up a scheme in the interest of unitholders, then prior consent of unitholder is not required. And as per Clause (b), a resolution by 75% of unitholders is a prerequisite, if unitholders want to wind up a scheme.
Regulation 39 (2) reads herein as –
(2) A scheme of a mutual fund may be wound up, after repaying the amount due to the unitholders,— (a) on the happening of any event which, in the opinion of the trustees, requires the scheme to be wound up; or
(b) if seventy-five percent of the unitholders of a scheme pass a resolution that the scheme be wound up; or (c) if the Board so directs in the interest of the unitholders.
The view of the bench was that findings of the High Court should be reversed, after making the categorical observation that seeking prior consent from unitholders requires in case of winding up a scheme, even though trustees have already decided to wind up, shall delay the process of publication of Public Notices, thus it would have a catastrophic effect on Regulations 40.
“The term ’Consent’ refers to the consent of Majority of unitholders and consent not given by individual unitholders who alone would be bind by their consent, the apex court discussed on the issue of unitholders raised then that consent shall be binding only on those who have consented to wind up of mutual fund schemes and cannot be imposed on others.” – the bench of Justice Abdul Nazeer and Justice Sanjeev Khanna referred to their order dated 12th February 2021, wherein they interpreted term ‘Consent’ vis a vis Regulation 18(15)(c).
“Principle of harmonious construction should be applied which, in the context of the Regulations in question, would mean that the opinion of the trustees would stand, but the consent of the unitholders is a pre-requisite for winding up.” – the Apex court also did the harmonious interpretation of Regulation 18(15)(c) with Regulations 39 to 42.
That Omission of Clause (d) to Regulation 18(15) and insertion of 18(15A) in SEBI (Mutual Funds) (Second Amendment) Regulations, 2000 is incidental.
The Apex court took reference to their order dated 12.2.2021 discarded the arguments that unitholders are laypersons and are not well versed with market conditions vide such order 12.2.2021, it speaks of the underlying thrust behind Regulation 18(15)(c) is to inform the unitholders of the reason and cause for the winding up of the scheme and to give them an opportunity to accept and give their consent or reject the proposal. It is not to frustrate and make winding up an impossibility.
Grounds on which Constitutional validity of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996
- Term ‘happening of any event’ is unambiguous – It doesnot mentions what kind of events would be covered in case of winding up of scheme.
- Cause (c) to Regulation 39(2), SEBI has been invested with the power to issue directions for winding up a mutual fund scheme only when it is in the interest of the unitholder
- No Provision for appeal or internal challenge against the decision of the trustees who may in a given case form a wrong opinion regarding winding up of the scheme.
Apex Court Counter –
“ If there is a violation of the regulations, i.e. clause (a) to Regulation 39(2), 39(3), 40, 41 or 42 by the trustees or the AMC, it is open to SEBI to proceed in accordance with law and in terms of Section 11 and 11B of the Act.
“It would be, therefore, incorrect to state that the decision of the trustees under clause (a) to Regulation 39(2) cannot be made subject matter of inquiry or investigation and therefore no directions or orders under Section 11 or 11B of the Act can be passed. No doubt, clause (a) to Regulation 39(2) gives primacy to the opinion of the trustees and does not require prior approval of SEBI, yet SEBI is entitled to conduct an inquiry and investigation when justified and necessary to ascertain whether Page 60 of 77 trustees have acted in accordance with their fiduciary duty and also for reasons which would fall within the four corners of clause (a) to Regulation 39(2). If the trustees have acted for extraneous and irrelevant reasons and considerations, the action would be in violation of clause (a) to Regulation 39(2) and therefore amenable to action under the SEBI Act, including directions under Section 11B.”